Afghan real business cycle theory

For the past decade, billions of dollars in American aid poured into one of the world’s poorest countries, providing previously unimaginable opportunities to thousands of Afghan workers.

Now, the boom is over. The Afghan economy, which had been expanding by as much as 14 percent a year, has slumped. Growth this year is expected to be just 3.2 percent, according to the World Bank. That slowdown reflects the declining American spending and also apprehension about security.

There is more here, tragic throughout. I like to say to my students “no matter how many good arguments you think you have against real business cycle theory, it explains an overwhelming preponderance of the business cycles in the history of the human race.”

And don’t get any silly ideas from seeing the word “spending” in that text above. This is an RBC story, and while nominal rigidities may well play a further role in the contraction, ups and downs in the real demand for Afghani products is the driving factor. If an economist wins a Nobel Prize and suddenly is in stronger demand on the lecture circuit, that is mainly an “RBC boom” for that economist, not a Keynesian mechanism just because others are “spending more” on him or her.

This is not a RBC story but a Keynesian story. The first two sentences of the blurb support the notion that ‘pouring money’ into an economy from government will artificially pump it up for a while, until the money stops. That’s Keynesianism 101. F for TC, lol.

“ups and downs in the real demand for Afghani products is the driving factor”- nonsense. According to the WaPo article, 75% of the Afghanistan economy comprises US aid. So ‘real demand for Afghani products’ comprises US aid to Afghanistan?

I say this is a story of what happens when you let government dictate an economy by spending money on it. You get a perverted, artificial economy (here, war driven) that has no “real” foundation, sorry to use that word in a Real Business Cycle article.

Only one good book has been written on Afghanistan and that is by Thomas Barfield. He points out that Afghanistan is so poor that basically it needs to sell itself to someone. Even though Afghans may hate everyone else on the planet, they still have no choice. So Karzai plays tough but he doesn’t mean it really because they need the cash.

Well, this is what happens when people take Middle East carpet salesmen at their word. They get up and leave. The question is who are the Afghans going to sell out to next.

Here’s a challenge: model this scenario using a basic Prescott RBC model, also using a basic new Keynesian DSGE model, and finally with an undergrad IS-LM model. Which one better fit the data? Which one has the more natural an intuitive interpretation? My gut says that the RBC model isn’t going to be the answer to either question.

Fortunately, “confirmation bias” isn’t something your students are likely to accuse you of. Forget that idiot who said:”A scientific theory should be as simple as possible, but no simpler.” What did he know?

I have to chime in with those who say this isn’t a real business cycle story, or at least not what RBC theorists had in mind at all. The heart of RBC theory is that real economic progress is inherently cyclical. A vastly poorer country being temporarily occupied by a vaster richer one doesn’t prove anything. Surely it’s not a credit cycle either.

I would say it’s not a cycle of any kind. One-off events aren’t cycles.

For that reason I don’t agree that RBC theory “explains an overwhelming preponderance of the business cycles in the history of the human race”. There is no compelling evidence of recurrent cycles in non-financialized economies. What are you talking about? The rise and fall of bronze age greek city states or the Persian empire? Not the same thing at all. The business cycle is something that repeats, and at a fairly regular frequency. In my mind the evidence is overwhelming that it’s finance that’s inherently cyclical, not technological progress.

RBC contends much more than that,- that there is something cyclical in the nature of technological progress, which is the underlying cause of the business cycle driving the apparent financial cycle. What it really boils down to is a stupid stubborn denial of the inherent cyclicality of credit.

I like to say to my students “no matter how many good arguments you think you have against real business cycle theory, it explains an overwhelming preponderance of the business cycles in the history of the human race.”

Or you could say, “Artificial savings can’t replace real savings.”

– or –

“The problem with poverty isn’t lack of money.”

But you can’t get a job at the Fed or World Bank thinking those sorts of thoughts.

Let me try to reconcile what Tyler may be saying: “The US Aid was a positive shock that caused a boom. Agents made optimal decisions based on this shock which had pretty good persistence for 10 years. Now that the aid has shrunk, a recession will follow as agents correct their consumption, labor and investment decisions.” So, yeah…that’s an RBC story! Yet, Tyler, a wise individual once said, “Once you start down the dark path, forever will it dominate your destiny, consume you it will.” Next thing we know, you will be spotted attending the SED meetings.

They invested in Afghan copper, but it turns out the world-class deposit is under an ancient buddhist shrine/temple/religious site. The excavation of that site has delayed the mine construction for years.

I’ll say it for Tyler, the comments on this post are really disappointing…do you guys really misunderstand RBC at such a fundamental level?

Real Business Cycle theory predicts that changes in output are caused by real factors , rather than nominal rigidities. The fact that so many are distracted by the term “technology” in the RBC literature is disturbing.

I’m not sure I’m following your last statement. First, shocks can be positive or negative so if prices are sticky and a positive shock occurs you’re left with a rationing issue (no increase in output so people have to queue up to get then next batch before it’s sold) not a recession. Alternatively if prices are not sticky and you have a negative real shock to demand it’s not at all clear that the quantity output demanded with the new prices will achieve the same real GDP, or support he same level of employment, so a recession could occur with prices adjusting.

I’m not sure I buy the RBC is all about supply shocks either — even if that’s how the idea is illustrated its clear that both blades of the sissors have both real and monetary elements.

There is no unemployment in RBC models. Output is determined by the levels of technology and the factors of production. This is the basic meaning of RBC theory. Since output is fixed, a negative shock to demand will be resolved only with lower prices.

RBC model doesn’t mean every possible model of business cycle caused by real shocks. It means the model that Prescott and Kydland came up with that models business cycles in a neoclassical growth model and shocks to TFP.

It can be a TFP shock other than “technology,” but in the end it has to be modeled as a TFP shock.

I think this story show’s how blurry the lines are between ‘real’ and ‘nonreal’ business cycles. If you want to say ‘there was a large scale shift in the relative value people placed on various good from various geographical regions.’ Well then sure, that is true. If you want to call that ‘real’ however, you should note that it isn’t terribly different than a Keynesian influx of money, as also that reflects a certain change in value judgements from people. Then we are just talking about how many people and how much value they have at their disposal.

Seems to me like we should be at a point in economics where we move past poor descriptors like ‘real’. This was a business cycle caused by a geopolitical event. That means it will probably have certain kinetics or spill-over, or duration, etc. I’d be way more interested in hearing your thoughts on those aspects, or how it might differ from cultural cycles, or technologically induced cycles than if you think it is ‘real’ or not.

A rapid fall in aid seems more like a textbook Keynesian exogenous demand shock (X-M) than a supply side shock. Of course with lower real incomes resources will need to be shifted from non-traded to traded goods — poppy production will become more profitable, for example — and the required recalculation will produce further falls in income, all a pretty Keynesian story..

This is not a real business cycle event. When an occupying power leaves a country – there is a ‘technology and physical capital’ shock, of course. But the ‘deep’ parameters of the country will change, too. A new political, legal and cultural system has to develop. RBC theory assumes a stable political, legal and cultural system (and demography, and tastes, whatever). Though there will be quite some involuntary unemployment, caused by lower spending, too. Unemployment which a wise government might mitigate, to an extent, by issuing more of its own money while at the same time preventing corruption, changing the tax code and capital and import controls to prevent large external deficits and continuing to promote companies and technological innovation (forget about financial innovation like stock markets but one might consider risk sharing lending, did you now that ‘sukuk’, the word for an islamic bond, has the same etymological root as our ‘check’) and non-rent property rights and to educate boys and girls etcetera. I’m not sure that will happen. Anyway – money is a technology, too. And the crisis will have, to quite an extent, a monetary nature.